23 Oct 2016

Insurance Cover Should Be Adjustable

Insurance policies today have a fixed cover that you can't increase or decrease later. You can only buy a separate policy, discontinuing the old one if you don't need it any more.

Increasing your cover with inflation

One problem with this is inflation. Everything is costlier each year, so your insurance cover should increase as well. Otherwise, it may turn out to be insufficient.

Especially over the decades. Suppose you're 30 today and buy medical insurance for 30 lac. That's a big amount, so you feel comfortable. But by the time you reach your 70s, it's likely to be worth only 1 lac, if present rates of inflation continue. That's too small an amount to serve its purpose.

Sure, you can buy another policy for a greater amount, but that assumes insurance companies are willing to offer you one. They aren't, if you develop certain diseases, even common ones. For example, people who have diabetes and take insulin are almost always denied medical insurance.

So, you can't count on being able to buy more insurance if you want to.

The government has guaranteed renewability for medical insurance, which means that no matter how sick you are, the insurance company can't refuse to renew your insurance. But the problem there is that the effective value of the insurance decreases every year, so guaranteed renewability doesn't do all it's supposed to do.

Guaranteed renewability should be inflation-adjusted. If you have a policy now, and prices inflate by 10% a year later, you should be entitled to increase your cover by 10%, by paying 10% more premium[1]. This should be guaranteed by law — insurance companies shouldn't be allowed to refuse the increase, or to increase the premium by more than 10%.

This should go for all other types of insurance as well, like life insurance, critical illness insurance and disability insurance. You should be entitled to increase the cover next year by the rate of inflation, by paying additional premium proportionally. Again, the insurance company shouldn't be allowed to refuse the increase, or to increase premium by more than the percentage increase in cover.

That takes care of inflation.

Decreasing your cover

But inflation is not the only reason one's need for insurance varies over one's life. As one's assets accumulate, one may have less need for insurance.

My financial advisor recommends buying 2-3 term insurance policies, each for a smaller amount, rather than one big policy. That way, if your need for insurance decreases later, you can discontinue some policies while retaining the others.

You shouldn't have to do this. First, not everyone knows this suggestion. Second, it's more bureaucracy, more forms to fill, more payments to make, more policy numbers to track, more terms and conditions to understand, and more policies to renew every year.

It should happen automatically. When you buy a policy for a crore, say, it should be treated as if you'd bought a crore policies for a rupee each. That gives you the flexibility, years later, to discontinue some of the policies while retaining others. And you can do that as many times as you want [2] [3].

When you decrease [4] your cover, for term insurance, your premium should decrease proportionally [5]. For medical insurance, it won't decrease proportionally [6]. It will be up to the company's risk estimation.


Summary

When you buy insurance, you should be entitled to increase the cover every year by the rate of inflation, and pay more premium proportionally. You should be able to decrease your cover

[1] You don't have to increase it if you don't want to. It's just an option. You can continue with the same cover for another year, at which point you'll have another chance to increase it.

This is not cumulative — if inflation is 10% each year, and you skip increasing your insurance cover one year, that doesn't entitle you to increase it by 20% the second year. That's up to the company. It shouldn't be required by law.

[2] But not increase your cover — that may require buying a fresh policy. (Except for inflation-indexed increases.) Again, this is no different from what would happen if you bought a crore policies for a rupee each. That gives you the right to decrease, but not increase, the cover anytime.

[3] This also lets the insurance company manage risk appropriately. They can just model it as a crore policies, and make appropriate investments.

[4] For medical insurance, which is typically offered in tiers, you'd be able to downgrade to the next tier, not to something in between. That is, if a company offers medical insurance for 20 and 25 lac, and you buy 25, and next year decide to downgrade, you won't be able to downgrade to 23, only to 20.

[5] This is also the case when you're buying afresh — buying insurance for 2 crores costs double that for 1 crore. So, if you later halve your cover, your premium should also halve.

[6] This is also the case when you're buying afresh - buying medical insurance for 20 lacs costs much less than twice 10 lacs costs. So, if you later halve your cover, your premium won't halve.

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